Insider Trading: Two Comments

Two old friends ruminate about insider trading. Treynor points out that the purposes of the U.S. insider trading laws are (1) to protect dealers and (2) to give investors the feeling that they are protected from people who know more than they do. He concludes that insider trading laws probably make capitalist societies healthier. LeBaron argues that when insiders are restricted, markets become less informed. He proposes that insider trading be encouraged at all times—but with the proviso that insiders be required to identify their market orders. Two old friends ruminate about insider trading. Treynor points out that the two purposes of the U.S. insider trading laws are (1) to protect dealers and (2) to give investors the confidence that they are protected from people who know more than they do. If dealers play an essential role in making securities markets liquid, capitalist societies have a stake in protecting dealers. If people who feel protected from insiders are more likely to invest, capitalist societies have a reason for providing that protection. So, capitalist societies are probably healthier with insider trading laws, but the laws are protecting dealers, not individual investors. Insider trading laws are not helpful to markets and most market participants.LeBaron considers laws against insider trading to be akin to excluding the most knowledgeable students from a test—with skewed results. He argues that if one of the primary jobs of markets is accurate price discovery, this exclusion makes no sense. When insiders are restricted, markets become less informed. Therefore, insider trading should be encouraged at all times—but with the proviso that insiders be required to identify their market orders so that other investors can judge whether the trading contains information. Moreover, companies should make continuous public markets—for example, as a specialist function with an open book and in continuous registration for capital raising or share buybacks. Companies should be the most informed insiders and should continuously reveal their pricing ideas by market behavior.